Description

Summary

Citron recently issued a report calling Angie's List the "most ridiculous, stupid, misunderstood, negligent, nonsensical, outdated, irresponsible business model in the new web economy."  The piece should give readers a sense as to basic structural flaws in the business model.  We share many of their views but acknowledge that the danger in shorting these hyped up and seemingly open-ended growth stories are that they are fueled by ridiculous sell-side assumptions and typically don't crack until the street is forced to wake up to certain realities.  Citron sums it up nicely: "In a bull market, it seems that the analysts look at a stock price first, then reverse-engineer a thesis, no matter how preposterous, to explain and justify its valuation." 

Fortunately, we believe that the business has reached an inflection point and the data suggests that soon the sell-side will be forced to re-evaluate their expectations on the profitability and even the viability of the business.  BAML's current price target is $27 - We believe they and the rest of the Street are fail to grasp the following:

• AL members and prospective members are becoming more and more aware to where AL's true loyalties lie and to the fact that AL offers no meaningful benefit to free alternatives
• This realization is having an effect on ARPU and AL's marketing efficiency as well as the rates SP are willing to pay to advertise

• Furthermore, the recent class action lawsuit against AL's deceptive renewal policies has forced AL to adjust its policy of renewing members at an inflated "Membership Renewal Fee" rather than the standard "Membership Fee" and will therefore drive a meaningful declines in ARPU regardless of the outcome of the actual case

• Overall SP growth has stalled, future growth potential is capped, and SP ad rates are declining rapidly in AL's most mature markets due to the fundamental dynamics of the ROI lifecycle of SP ads

• The highly touted e-Commerce initiative is completely unproven (arguably its been proven to be bad idea in other marketplaces) and is already experiencing lackluster growth and will ultimately result in overcharging and alienating SPs and members

Broken Concept of AL's Subscription Service

A few questions to ask yourself before we dive into the data: 

• Would you pay a fee to write reviews that force you to disclose your identity and open yourself up to potential Service Provider backlash: http://www.forbes.com/sites/nextavenue/2013/01/07/the-perils-of-posting-scathing-reviews-on-yelp-and-angies-list/

• AL caters to high failure rate projects: how often are you remodeling your home or needing AL services to justify paying a recurring annual fee?

• AL loves to brag that Service Providers cannot pay to get on AL but in reality they are aggressively solicited by AL to advertise as long as they are rated at least A or B - so how does AL expect to maintain their commitment to their members when nearly 70% of their revenues come from Service Provider advertisements?
• The CEO has said AL has an internal saying along the lines of "All ties go to the member" - how can AL ever see any issue as a "tie" when the Service Providers produce more than DOUBLE the revenue of members?

• AL actively solicits reviews through phone calls and emails - is there a risk to bias considering they want Service Providers to be rated A or B so as to have a wider pool of potential advertisers?

• BAML claims that AL is in "early stages of realizing the benefits of a strengthening network effect that should contribute to 25%+ organic growth for 4-5 years."  But this isn't a new idea - its been around since 1995 and launched its website in 1999- any meaningful network effects should be evident by now so why has AL NEVER achieved any level of profitability? 
• Also "network effects" can work in both ways and a Google search of "Angie's List reviews" paints a very bad picture of the service - so judging from AL's current online reputation will word of mouth network effects work for or against AL going forward?

• Are AL reviews really that much better than what you can get for free from competitors?

The last point is important as it is essentially AL's supposed competitive advantage.  If one can get over the annual fee and the incessant spam from AL soliciting you to write reviews, then a subscriber needs to believe that the proprietary reviews are significantly better than others available for free   AL claims that their reviews are better because members must buy a subscription, cannot post anonymously, and are "certified" by a 3rd party auditor.  However there is:

• No Reliability
1. AL offers a 110% refund guarantee for all subscriptions so that  is a low (no) barrier to anyone who really wants to skew reviews
2. Posting under a real name doesn’t matter if there's no way to verify that the poster has actually received/paid for the service they are reviewing

• No Discernment
1. Posting under a real name doesn't mean one can accurately judge the work being done
2. These high failure rate services are more objective than they are subjective (a proper and quality plumbing or roofing job is different than whether you enjoyed your dinner at the new Italian restaurant around the corner)

On sites like Yelp, you can get a good idea of the poster even if he is posting under a pseudonym by seeing how many other reviews he has written (reliability) and hopefully seeing a range of ratings from good to bad on those reviews to see if you agree (discernment).  The problem with AL reviews is that the majority of them are from members who have only reviewed 1 or 2 service providers - that combined with the nature of the services being provided results in the absence of the two most important factors of an online review: reliability and discernment.

AL must paint a picture of a highly engaged, affluent, and rapidly growing membership base that can provide solid leads to its Service Providers to justify ever increasing advertising rates 

Membership growth has accelerated meaningfully in the past few years with total paid members more than quadrupling from YE 2009 to YE 2012.  ARPU has also fallen meaningfully over this same period but the growth in members has obviously more than made up for it.  In addition, AL likes to point to increasing marketing efficiency in the form of a decreasing CPA (cost per acquisition) of $85 to $73.  This metric uses GROSS paid memberships added which includes monthly memberships and doesn't take into account the members that are lost every year.  A more meaningful metric is the CPnetA which is projected to begin to increase (even using optimistic BAML estimates) this year.

We believe BAML estimates are far too optimistic as they are predicated on historical renewal rates of 78% - however because of the massive increase in new members in new markets this 78% figure cannot be relied upon as an indicator of member renewals going forward as we estimate that slightly more than half of the 1.6mm paid annual memberships at YE 2012 (9% of membership base are monthly members) were new members that signed up in the prior 12 months.  That’s more than all the new members that signed up over in the previous 24 months (2010-2011) and more than all the new members that signed up from 2007 to 2010 combined.  Even if I thought Angie's List was a useful service (which I obviously don't) having such a massive proportion of your membership base being brand new should cast serious doubt on any historical member metrics.  Management priorities have drastically shifted in that same period as well with the revenue split going from approximately 50/50 between Service Providers and Members to nearly 70% from Service Providers.  This shift has not gone unnoticed by members.  Some anecdotal evidence from user comments at IBJ.com (Indianapolis Business Journal - Indianapolis is the hometown and oldest market of AL):

"I was a member of the list for several years beginning in 2000. I for several years was very happy with the service. I used several vendors with good credentials on the list and had great result. However, a couple of years ago I noticed the price jump for membership and declined to renew. At first Angie's felt like a locally run neighborhood organization but in the last few years it has begun to feel more like a corporate giant."

"We are long time members dating back to the original Unified Neighbors days. We've noticed over the Angie's List years a culture change toward being more mercenary and profit motivated, less service oriented. Reminds us of our experience with satellite radio for our car where it is very difficult to cancel once they have your credit card number."

"I am a longtime Indiana subscriber. I just checked my bank account on line and discovered I had been charged $88.50 for a renewal membership which is exorbitant. I will be cancelling my membership."

From the 10-K:

"Increasing new paid memberships is our key growth strategy.  Increased penetration in a market results in more member reviews of local service providers, which increases the value of our service to consumers and drives further membership growth in that market.  Increased penetration in a market also drives increased advertising sales to service providers and supports higher advertising rates as the pool of members actively seeking to hire service providers grows...We expect marketing expense to increase in future periods as we continue to advertise to acquire new paid memberships." 

This expectation of increased ad sales might explain AL's decision to offer membership rates at a 70% discount in some recent cases to build its number of paying subscribers.  However, as we will discuss later, we believe that ad rates in any market cannot grow proportionally with membership growth and the data shows that AL has already been feeling these effects.  ARPU has been decreasing at an accelerated pace over the past couple years with the first significant 10% yoy decline 3 years ago explained by the introduction of "an unbundled pricing structure in certain of our more established markets."  This unbundled pricing structure began with 36 markets in 2010 and has grown to 78 as of Q1 2013.  This new pricing structure allowed new member to subscribe to either the original Angie's List which offers "Home, lawn, car, pets and more" or Angie's List Health & Wellness for "Physicians, dentist, hospital and more" or both through "Angie's List Bundle."   

The average Membership Revenue per subscriber(ARPU) has fallen by over 40%  since 2009:

AL and street bulls have highlighted a lower marketing cost per paid membership to offset the declining ARPU but when looking at the actual numbers it is clear that the declining ARPU has far outpaced any improved marketing efficiencies with the differential rising from (10) in 2007 to (40) in 2012.

I would argue that the drastic cuts in membership price (along with the 110% Money Back Guarantee)  rather than the touted optimization of marketing strategies have been the real driving force behind the AL's continued membership growth rate. 

Bulls can still point to the strong trend in average membership renewal rates:

So an improvement in GROSS marketing spend efficiency combined with high membership renewal rates should result in strong NET marketing spend efficiency right?

Wrong, marketing cost per NET paid member added reached a trough in YE 2012 and using BAML's own estimates will rise consistently over the next few years 

Furthermore, we believe historical average membership renewal rates will not be reflective of future rates due to a shift in the public's perception of AL due to it's deteriorating reputation both online and through word of mouth, an increasingly annoying member experience due to spam and constant review solicitation, a more aware and vigilant new generation of members that won't be oblivious to the annual renewal of a service they don't use, and the ease with which a member can cancel their membership today relative to the barriers and shady renewal tactics characteristic of prior years. 

An even more straightforward reason why future renewal rates will likely differ from historical rates is that AL has entered over 80 new markets in the past few years and we estimate (by simulating renewals since 2007 and assuming a simplistic distribution of 75/25 for 1/2 year members) that nearly 860,000 (over ~53%) of the AL's membership base as of YE 2012 had joined within the prior 12 months.

Another unknown factor in this new membership base is the degree to which it will take advantage of AL's 110% Money Back Guarantee.  AL offers a 110% Money Back Satisfaction Guarantee on all annual memberships.  That means that anytime before the expiration of your membership you can cancel your membership for a full refund plus 10%.  So if you signed up for a 4 year membership back in 2009 you can cancel today and get a full refund plus 10%.  We've verified this with AL and have actually tried this several times and can confirm that AL will refund the membership and send a paper check for the additional 10%.  With such a generous policy we thought AL would have some reserve line item in case a some percentage of new or existing members weren't satisfied with the service but we weren't able to find any mention of a reserve or the 110% guarantee in any public filings.

As AL loses more and more new members to non-renewal/cancellation they will need to spend more and more on marketing if they want to show improving gross marketing efficiency (which is a metric they have trained the Street to track).  So either marketing efficiency will drop (marketing cost/gross acq will increase) or marketing spend will skyrocket and marketing efficiency will continue to improve but overall membership growth will lag significantly.  So no matter what it will become harder and harder for the Street to put a positive spin on future results.

If AL does ramp their marketing that might actually accelerate their demise.  AL marketing is all about building its brand and awareness so as to acquire more paid members but one of their BIGGEST selling points is that businesses can't pay to be on Angie's List: "Angie's List is a consumer-driven service supported by membership fees."  But all the marketing dollars in the world won't be able to blind members and prospective members to the fact that their REAL business revolves around advertisers.  An idealist inside ANGI is trying to serve two masters which is impossible - the realist inside ANGI is trying to serve Advertisers yet must base the ENTIRE marketing campaign on the fallacy of serving the consumer which is unsustainable.

Unbundling, discounting, and the recent Class Action suit will continue to pressure and possibly accelerate the significant declines in member ARPU

AL claims that their new "dynamic pricing model" is a better value proposition for members while Citron claims that this attempt to enter a new vertical "further exposes the complete stupidity of their business model."  The inappropriate handling of this "unbundling" and shift in the pricing structure for pre-existing members is also one of the main allegations of the class action lawsuit filed against AL in August 2012.  AL's pricing structure and recent discounting suggests that in many developed markets the additional Angie's List Health and Wellness has had weak growth and is seen to be of negligible value to new subscribers. 

For example in Indianapolis, one of AL's original and oldest markets, the 1 year price for the Angie's List Bundle  was $62.40 and for Angie's List (original) was $39 as recently as April 2013.  Sometime in May, the pricing dropped almost 40% to $39 for the Bundle and $35 for Angie's List.  The implied value of Angie's List Health & Wellness went from $23.40 to just $4.  This drop occurred across other older developed markets such as Chicago, Charlotte, Tampa, Houston, Dallas and many others. 

The listed membership rates are actually meaningfully lower as 40% discounts are readily available online.  "Angie's List promo code" is the 2nd suggestion from Google when searching "angie's list" and the first hit provides a code for 40% off membership plus an additional 20% off if you pay with Paypal.  Theoretically, this means the Angie's List Bundle listed at $62.40 as recently as a month ago can be obtained today for $18.72 (70% discount). 

Now this should be setting off alarms as a business with "strengthening network effects" shouldn't have that drastic of a price decline especially in one of its most mature markets.  Generally, membership rates are higher in older markets so why is this rate more than 40% lower than the average ARPU of $33.34 across the entire membership base (which includes many lower priced memberships in the mid-teens from newer markets)?  The $18.72 rate is less than HALF of the ARPU of $43.08 disclosed in the Market Cohort Analysis section for the Pre-2003 Cohort of which Indianapolis is a part of.

How can this type of discounting and pricing possibly fit in with the data reported in their filings?

This leads us to our next issue with BAML estimates - even if we were to believe AL could maintain renewals, how can BAML justify their projected rate of decline in member ARPU. 

BAML is estimating a 9% drop to 30.29 in 2013 which makes no sense considering we just showed that membership today in one of the oldest and most expensive markets is nearly 40% lower at $19.  AL doesn't provide guidance on member ARPU but does expect ARPU will continue to decline as they introduce unbundled pricing  to more markets: "We anticipate unbundling our offerings in more of our markets as market penetration increases...we expect that this strategy may result in lower average membership fees per paid membership overall..." 

Considering the fact that listed membership rates in the newer and faster growing markets are in the low to mid teens (single digits after discount) and the listed rates of the more mature markets are currently in the mid 20s to mid 40s range (mid teens to mid 20s after discount) - The real question is why ARPU hasn't been dropping EVEN FASTER over the past couple years considering the combination of steady price declines in mature markets and the readily available 52% discounts (stackable 40% and 20% discounts) off of the listed rate.  We believe the answer lies in AL's abusive renewal policies which are addressed in the Aug 2012 class action lawsuit.

The suit seeks "monetary relief for Angie''s List's systematic and repeated breach of its membership agreement, and for fraudulent and deceptive conduct relating to the fees it collects through the automatic renewal of its members' subscriptions."  The suit basically accuses AL of automatically renewing memberships at a higher "Membership Renewal Fee" instead of the standard "Membership Fee":

"9. In breach of the plain language of its Membership Agreement, Angie's List instead automatically renews its members pursuant to a distinct - and more costly - 'Membership Renewal Fee.'

10. In this manner, Angie's List has breached its own membership contract over one million times.

11. Nevertheless, Angie's List has continued to deceive and defraud its members and prospective members through public statements and electronic transmissions conveying the false impression that new and renewing members are charged pursuant to an identical membership fee schedule.  In fact, the so-called Membership Renewal Fee is not identified in the Membership Agreement or in any of Angie's List's numerous publications regarding its membership fees"

Recall that AL shifted to an unbundled pricing structure in 36 of its most mature markets in 2010 - AL did not notify its long time members of this pricing change and instead blatantly abused their auto-renew policy.  The suit goes on further to point out that these longer-tenured members were taken advantage of by being auto-renewedat the highest possible Membership Renewal Fee for the Bundled membership (as high as $88.50 - remember the average membership fee was $33.34 in 2012 with the most expensive markets averaging $43).

Exhibits B and C plainly show that the "Membership Renewal Fee" was 79% higher on the Bundle, 25% higher on the "original" Angie's List and 218% higher on Angie's List Health and Wellness!

Also from the suit:

"67. Angie's List has so effectively  concealed information about its "Membership Renewal Fee" that The New York Times, in a detailed March 2012 profile piece on Angie's List, inaccurately reported the range of Angie's List membership fees."

There is obviously ZERO justification for charging such exorbitant fees when a member could have simply cancelled their membership and re-signed up at the listed Membership Fee other than to systematically and stealthily take advantage of a member base that was prone to forget about a membership they had signed up for a year ago.  There are countless complaints online about the shady renewal tactics used to keep the money flowing. 

This price gouging of renewed members is the missing piece in explaining how annual ARPU has ONLY declined from $55 at YE2009 to $33 at YE2012. 

The bad news for AL is this lawsuit has forced them to discontinue this dishonest practice.   They have since revised their Membership Renewal Fees to be the same as their listed Membership Fees.  We estimate that over 1.2mm members (simplistically assuming a 75/25 split between 1 and 2 year members across the membership base) will be up for renewal in 2013 and without the outrageous Membership Renewal Fees to balance out all the newly acquired members , we expect the Annual ARPU will decline more drastically than the 9% modeled by BAML.

It's amazing that even after this irrefutable evidence, AL maintains in their 2012 10K that it was all done in the best interest of their members - claiming that they are trying "to offer members the opportunity to purchase only those segments of Angie’s List that are most relevant to them"(implying they gave members a choice which we know to be false). "We believe this pricing model will enable us to offer a better value proposition to our members and preserve cross-selling opportunities as members' needs evolve" (why expend the effort in cross-selling when you can just deceptively force-sell your members during the renewal process without their knowledge).  At least, AL fesses up to their real motivations at the end:  "Although we expect that this strategy may result in lower average membership fees per paid membership overall, we believe the new members generated by this pricing model should ultimately produce increased service provider revenue per paid membership."

This leads us to the most crucial aspect to the short thesis which is whether AL can generate sustained and meaningful service provider revenue growth.  By now it should be clear that although AL likes to portray themselves as a friend and advocate of the consumer that ultimately what they are after is the pockets of the Service Providers.  They've done a good job in getting the Street to buy into their strategy of aggressively investing in marketing in hopes that this will result in higher Total Revenue/Sub which is the sum of Membership Revenue/Sub and more importantly Service Provider Revenue/Sub.  So the thinking goes that as long as they can increase SP Revenue/Sub at a faster rate than their ARPU decline then their strategy must be working.

Bulls will argue that the AL business model and ultimate path toward profitability is highly dependent on the Service Provider/advertising side of the business and that increased memberships and market penetration will lead to higher advertising revenues.  On the surface, this strategy seems to be working as SP revenue increased 92% YoY in 2012 while Membership revenue gained just 41%.  AL has accomplished this through a combination of increasing the number of paid SP and increasing ad rates.  The true deciding factor will be whether these increases are sustainable.

BAML believes AL will achieve GAAP profitability by 2014 and looking at their projections its difficult to assess whether they are reasonable or not.  The revenue growth seems reasonable with growth slowing over time.  The decline in selling costs is questionable as all salespeople are paid on commission but maybe a 6% drop (as % of Rev) is not entirely unrealistic as they can argue that commissions on SP contract renewals are significantly lower than originations (this actually conflicts with AL hiring patterns with AL adding 4x more sales personnel to their origination and ecommerce teams (+407) vs. their renewal teams (+95) in 2011 and 2012).

We believe the best way to reveal how ridiculous these estimates are is by applying them in the context of a market cohort analysis.

AL divides their 200+ markets into 4 major cohorts: Pre-2003, 2003-2007, 2008-2010, and Post 2010.

The pre-2003 cohort includes AL's ten most established markets. The markets in this cohort include several mid-sized urban markets in the Midwest (including Indianapolis, Charlotte, Tampa, Cleveland) as well as Chicago and Boston.  Of these 6 known markets (which we have gathered from public disclosures), 5 have experienced listed membership price discounts similar to the 40% drop in the Indianapolis market we discussed earlier.  This is not what we should expect from AL's most seasoned markets as membership prices should be stable, or arguably even slightly increasing as the value of the collective reviews and multitude of supposedly vetted Service Providers should provide the best value for existing and prospective members.  At the very least, the Total Revenue/Sub SHOULD be increasing as the increased penetration and # of paying members SHOULD warrant higher ad rates from service providers.  However, using BAML's own estimates for member and SP growth as well as BAML's projected member and SP revenue, the Total Rev/Sub will actually DECREASE 5% from $154.56 (YE2012) to $146.94 (YE2013) and fall another 10% to $132.56 by YE2014.

We believe that the aggressive membership price discounting in the Pre-2003 markets may suggest the markets has become saturated - what other reason could there be for 40% discounts off the listed rate (not even taking into account the additional 52% discount from promo codes)other than a desperate attempt to continue to show strong subscriber growth in hopes that it will translate into higher SP rev/sub.  Unfortunately for AL, SP aren't having it: The SP Contract Value/Sub is the Average SP contract value divided by the average # of subs in a market; this indirectly shows the value SPs ascribe to the membership base they are advertising to and its not pretty: a 19% decline in 2012 followed by projected 24% and 29% declines in 2013 and 2014 - and that's all if ANGI can achieve BAML's growth projections.

Following AL's Q1 earnings, BAML noted: "Older cohorts still seeing strong subscriber growth and marketing leverage."  We would argue the strong subscriber growth is more a function of severe discounting rather than any improved marketing leverage.  On the contrary, the Marketing Cost/Net New Sub has actually been on the rise (increased to 115.74 in Q1 2013) and by 2014 is projected to be more expensive than the Total Rev/Sub.

Moving on to the 2003-2007 cohort which include many of AL's largest potential markets:

This cohort is where AL derives over 60% of its total revenues and is also where AL faces the most competition.   We can see that while Total Rev/Sub grew in 2012 and is expected to grow in 2013 it looks like it is on the same trajectory as the Pre-2003 cohort but just a year or two behind.  SP in this cohort are also pushing back aggressively on pricing with a 22% yoy decline in SP Contract Value/Sub in 2012, a 5% sequential decline to 0.17 in Q1 2013, and projected 22% and 23% declines in 2013 and 2014.

The 2008-2010 cohort still has "predominantly introductory membership and advertising rates.  The markets in these cohorts generally are smaller markets that we entered to fill out our national presence."  The average number of households/market  in the 2008-2010 cohort is 60,000 and for the Post 2010 cohort is 20,000 - compare this against 425,000 and 435,000 in the respective Pre-2003 and 2003-2007 cohorts.  This drastic difference in market size is reflected in the membership pricing as well as the average SP contract value:

Here BAML projections suggest that ARPUs will rise 9% and 12% which we can only assume can be justified by the transitioning from introductory rates to the higher rates that are more in line with established markets - however we believe these growth rates are optimistic considering the -10% growth in 2011 and the measly 1% growth 2012.  However, we have noticed that listed rates in El Paso, TX, a market we believe to be in this cohort, have jumped almost 50% above what they were a month ago and have had a $5 Account Activation Fee surcharge added to the price of the membership as well.  Even if these markets were to achieve these increases in ARPU the Total Rev/Sub still trails the Marketing Cost/Net New Sub by a very wide margin: $39.52 vs. 107.02.  Our analysis suggests that in order to tie out with BAML estimates, AL would need triple its SP Rev/Sub in the next two years and even after such astronomical growth they still wouldn't be profitable on each marginal subscriber as acquisition costs are estimated to be $125.17 vs. a Total Rev/Sub of $93.61.  We are skeptical of this type of SP Rev/Sub growth as the SP Contract Value/Sub in this cohort is already double the rate of more mature cohorts at 0.36/sub.  How can SP in different cohorts be willing to pay such disparate rates? 

We believe it has to do with the different value proposition of advertising with AL in a new market vs. a more established market.  The key is that as a market matures more and more SPs are vying for placement in the top 5 results (20 displayed per page) of any given search (plumber, roofing, handyman, etc.) and SPs will pay top dollar to get that type of placement.  So in a young market where there are less than 100 SP per market even if the number of average members you can reach is a fraction of a larger market (4,026 vs. 27,803) you might still be willing to pay $100/month or $1,200/year to be the top result in your market.  However, these ad rates do not scale proportionally with increased membership in a target market because no one wants to pay to be more than half way down the page much less the second page of results.  In large markets like New York or the Bay Area there are only 8-12 paying SPs for a plumber search and chances are more than half of them aren't getting a good ROI on their ad dollars.  This is because in a mature market consumers will always gravitate toward the best rated, most reviewed, and highest placed and once you become one of those lucky few it becomes a self-fulfilling prophecy as long as you continue to provide quality service.  That's why there are always a few instances in every market where a SP will rave about Angie's List and how great it is for their business but they are by far the exception.  There also seems to be an upper limit of ~$5,000 for the Average SP Contract Value in the 400,000+ household markets and we're willing to bet that this upper limit will be much lower in a market with 60,000 (the 2008-2010 cohort) or 20,000 (the Post 2010 cohort) households.

This dynamic explains why AL was desperate to expand into new verticals because basically there is a limited amount of high ROI screen real estate to sell and only so many plumbers per market that will ever pay for those spots - and seeing as how they had already aggressively expanded into every possible market in the nation and were still nowhere near profitability - the brilliant minds at ANGI got to brainstorming…

"So we were able to 'revolutionize' the online review space by playing both sides… no one with any business sense thought we could carry on this scheme for this long but we were able to turn an inherently flawed business model into a $1bn+ market cap money losing operation - now what's another time-tested and proven money losing business venture we can revolutionize?  It needs to have multi-billion dollar potential so we can come up with huge numbers to wow our buddies on Wall Street and it would be great if we could play both sides again while claiming that we aren't and we definitely want to enter a space where there's already lots of competition… what better than our own version of Groupon, LivingSocial, and Google Offers and we'll call it 'Big Deal' "

e-Commerce Opportunity is No "Big Deal"

Think of Big Deal like every other daily deal site you've seen.  It offers deals at 50-80%+ discounts to some inflated Value with a countdown to when the Deal expires except that these Deals never really expire because they're just another way that SPs advertise their regular services to AL's membership base.  The only difference is now AL has an excuse to spam your inbox with even more irrelevant junk.  AL has a 24% average take rate on the value of the buy it now deal so 1 of three things is happening:

1. You're really getting a deal and the SP is losing money/taking a huge hit to their margins

2. You're overpaying

3. Both 1&2 and AL has proven that they have once again mastered the art of playing both sides

Let's think about the original intent of these daily deal sites; think Woot.com (true geeks will remember this) or Groupon when it was still cool.  The deals were either a quick and novel way to sell off excess inventory (Woot.com) or they were a way for a restaurant or other business to get their name out to customers in hopes of REPEAT business.  These businesses would be willing to provide a meaningful discount to the ACTUAL value of a meal or service for a short period of time to generate buzz and brand awareness.  The point was NOT to use it as a form of constant advertisement or a platform to sell your services indefinitely.  The fact that daily deal sites have devolved into the latter defeats the entire point and destroys the entire value proposition because the consumer no longer believes they are getting a 50%+ discount since obviously a business couldn't survive  if it was perpetually selling something for half of what it was worth.  Yet this is the entire premise of the Big Deal - so basically AL has devised a way to rip off both the SP and the member once again.

The Storefront is exactly what it sounds like - it’s a virtual store front for service providers where they can have a ENTIRE STORE of buy it now deals (again where AL will have a 24% average take rate).  Don't forget e-commerce sales personnel earn commissions based on this revenue so it really isn't that scalable either.

CEO Bill Oesterle recently presented on the opportunity at the 2013 Stifel Internet, Media & Communications Conference. 

Some of his main points were:

• Roofing, Plumbing, and Handymen comprise over 20% of SP Revenue.

• AL "facilitates" $3-4Bn of transactions annually by matching SPs and members.

• There were 200,000 buy it now transactions in 2012 with a 24% average take rate which resulted in $14.5mm of revenue up from $6.7mm in 2011

• Was very proud of Q1 2013 e-commerce revenue of $4.7mm (BAML, one of AL biggest cheerleaders, was disappointed in the "Sluggish eCommerce revenue growth")
• "We've gone from 0 to $4.7mm worth of this revenue in the first quarter. That is recurring revenue, these are businesses that are putting offers up on our site, a destination site, its recurring so we're effectively building on that base" (emphasis added - although he did mention it twice in the same sentence)
• I really wonder if Oesterle understands the meaning of recurring revenue or if he thinks that by saying it twice we will just believe him since Big Deal Buy it Now revenue is anything but recurring revenue. 

What really boggles my mind is how Oesterle completely contradicts himself in that very quote - he characterizes this revenue as recurring and that AL is effectively building on that base yet AL had 3.8mm of e-commerce revenue in Q1 2012 so if this really is recurring revenue that you're building off of doesn't that mean you went from $3.8mm to $4.7mm from 1Q12 to 1Q13?

• Even the BAML analyst agrees here: "we think that with eCommerce rev. moving to a more recurring format (Storefront) vs. episodic (ie Big Deal), the stock could get more credit for the opportunity."  I'm skeptical of the recurring nature of even the Storefront and disagree that AL should  be getting much credit for either opportunity but at least we agree that Big Deal revenue is episodic in nature and their e-Commerce figures include both Big Deal and Storefront revenue and is currently more heavily weighted toward Big Deal revenue.

• Oesterle also states that the average ticket size of current Big Deals is $150 but AL estimates that the average ticket size for the entire business is $1,500 so lots of upside!!!!
• The Stifel analyst is buying it: "So you don't need much of a penetration here to make a tremendous difference in how you get paid!?"  Oesterle: "No."

• "We’ve constrained it exceptionally narrowly because we're going through this process of qualification of the service providers, a key function … there's a willing… lots of people are willing"

One of my favorite parts which I had to listen to several times actually to try to understand (I still don't really get it) is when asked why SPs would be so willing to pay 24% of the total value of the service, Oesterle responded:

"24% has been remarkably durable through the first year and a half of learning...We're also getting insight into ROI now cause when you can see the transaction go all the way through you understand exactly what the transactions worth and the SPs that we're pulling into this are giving us information on the ROI... just the buy it now functionality that we provide...take significant...the cost of a marginal lead for a SP is incredibly high as it exists today in local services cause there's just, the tools are so terrible so if you are a dry cleaner or a plumber and you want a marginal customer in a geographically fixed area that’s relatively small you have almost no alternative and your cost of acquisition might be 2 or 300% of the actual ticket price of the job so we're providing an actual job, a marginal job, and we're charging 24% on average.  This is why when a service provider lights up a storefront offering with us and it starts to sell they don't take it down because we've lowered the cost of marginal business for them and we haven't even really gotten started with applying things like payment collection, things like route optimization, all these other value added components like seamless communication with the member these are all value added components for the SP...We are going about a process of completely deconstructing local service provider transactions and rebuilding them by applying the best business practices we can find."

Our responses:

• "24% has been remarkably durable "
• Sure! On the $88mm notional transaction volume you've done in the past 2 years (combined $21.2mm 2011&2012 e-commerce rev) out of a supposed $6-8 BILLION market opportunity ($3-4bn annually)

• "no alternative and your cost of acquisition might be 2 or 300% of the actual ticket price of the job so we're providing an actual job, a marginal job, and we're charging 24% on average"
• Not sure what alternatives he's referring to but am I supposed to believe that it costs a plumber $400-$600 every time it acquires a marginal customer on a $200 plumbing job - there is no way any plumber runs his business this way (unless the "alternatives" he's referring to is paying $3,000 to advertise through Angie's List and getting <$1,000 worth of marginal business - I guess from that perspective StoreFront might be less of a ripoff than AL's traditional services)
• One of the start up disruptors in the local home services space that we had looked into when researching AL competitors was RedBeacon which was acquired by Home Depot in early 2012 and one of the main criticisms we heard from an ardent Angie's List Service Provider is that RedBeacon charges a take rate of 25% for matching a SP to a job.  He claimed that sometimes he didn't even make that high of a margin after taking into account all his costs so SPs who used RedBeacon would be forced to overcharge for their services - AL is a couple years late to the party but AL is now putting its SPs in the exact same position

• "when a service provider lights up a storefront offering with us and it starts to sell they don't take it down"
• Storefront has been in existence for all of a year? 2 years? You barely have the metrics to even have an average life of your storefront SPs so it seems a bit presumptuous and a tad bit early to be saying that SPs will never abandon Storefront and that its the holy grail they've all been looking for

• "We haven't even gotten started...we are going about a process of completely deconstructing local service provider transactions and rebuilding them by applying the best business practices we can find"
• This deconstruction is exactly what RedBeacon (and many other local startups) have been trying to do for the past few years and the critiques to this revamping of the status quo is that all the tools in the world really aren't a substitute for having a phone conversation or an on-site consultation with a knowledgeable service provider on what the customer needs so building out all the technology is great but might not be worth it to the SP if he has to sacrifice a quarter of his revenue

At the end of the conference, Oesterle describes an arrangement that sounds similar but more convoluted to that between Home Depot and RedBeacon where he continues to try to convince us that AL can provide simultaneous benefits to both the SP and the Member without favoring one over the other:

"Interestingly we now are in a position - and we're doing this - we have engaged in relationships with large suppliers to begin to - if you're one of the providers with us we actually can provide product purchasing power and some of that we can share down to the consumer so we have been working with some of the large product manufacturers to offer offers directly to the consumer but that are only available for fulfillment through the service providers that we have screened and qualified which means the consumer's benefiting from direct pass through from the manufacturer and the service provider is benefiting because they are getting the pull through of a manufacturer's discount"

There is no evidence and management's track record provides few assurances that this rebuilding of local service provider transactions will prove profitable but we assume AL will find any and every possible way to extract value from the SP, Members and ANGI Shareholders (through future secondaries) to enrich themselves and invest in all the technology, personnel, and processes to attempt this pipedream.  If AL can somehow miraculously perfect this down the road then maybe any profits they make in the Storefront can subsidize the endless losses from the old business but if Big Deal Buy It Now deals are any indication of the types of Storefronts they will be opening then there isn't much we need to worry about as shorts:

Currently the Most Purchased Deals are a variety of home security packages ranging from $100-$300, several Resume/Cover Letter Writing and Review packages for $100-$200, Computer Tune-Up services for $60-$100, and a $25 offer to help you "Launch a Design Competition for your Next Home Improvement Project"

If you've made it this far, you'll notice I haven't provided a target valuation - I believe this business shouldn't exist and is essentially a terminal short.  If AL decides to completely revamp its business model, come clean and focus on serving one party, either SPs or Members, and somehow through all that are able to retain the base that they've acquired then maybe there's a sustainable business in there somewhere.  Citron pegged ANGI at $5.50 - $6.88/share and we think that's being generous.

AL's most recent Q1 results were viewed as a further validation of their strategy with shares up nearly 30% on the day. 

AL beat the street's top and bottom-line estimates and issued better than expected Q2 sales guidance as well as lower than expected Q2 marketing spend implying lower subscriber acquisitions costs all of which led to a much celebrated positive FCF guidance for 2013.

BAML noticed the declining member ARPU but downplayed it since "over the long-term, AL's model would transition to an advertising and eCommerce model, with modest subscriber revenue as a % of total."  OK, we agree so what matters is advertising and eCommerce growth then right?  Interestingly the two other major negatives they pointed out were "Service Provider deceleration" and "Sluggish eCommerce revenue growth" yet they still rated ANGI as their "Top small cap idea" and increased their price target from $23 to $27.  Seeing as how BAML can have such blatant internal inconsistencies in their core thesis its no surprise that they have also missed the many inconsistencies between their future estimates  and recent trends discussed in this write up.

Catalyst

We believe that the business has reached an inflection point and the data suggests that soon the sell-side will be forced to re-evaluate their expectations on the profitability and even the viability of the business.

• AL members and prospective members are becoming more and more aware to where AL's true loyalties lie and to the fact that AL offers no meaningful benefit to free alternatives
• This realization is having an effect on ARPU and AL's marketing efficiency as well as the rates SP are willing to pay to advertise

• Furthermore, the recent class action lawsuit against AL's deceptive renewal policies has forced AL to adjust its policy of renewing members at an inflated "Membership Renewal Fee" rather than the standard "Membership Fee" and will therefore drive a meaningful declines in ARPU regardless of the outcome of the actual case
• Overall SP growth has stalled, future growth potential is capped, and SP ad rates are declining rapidly in AL's most mature markets due to the fundamental dynamics of the ROI lifecycle of SP ads
• The highly touted e-Commerce initiative is completely unproven (arguably its been proven to be bad idea in other marketplaces) and is already experiencing lackluster growth and will ultimately result in overcharging and alienating SPs and members